Yesterday, the RBI announced in-principle Payment Bank licenses for eleven applicants. To put things in perspective, there were two new bank licenses in the last decade. The successful applicants include the largest telcos, corporate houses, Business Correspondents, a Depository and a mobile wallet provider. The number of licenses and the diversity of the pool bode well for the scale and scope of what will be pursued by this new category of banks in the years to come.

While previous licensing rounds were always for “full-service” banks, this represents the first round of licensing for a differentiated banking design following on RBI’s Discussion Paper on Differentiated Banking and the recommendations of the Committee on Comprehensive Financial Services for Small Business and Low-Income Households. To recap, a Payment Bank can provide deposit and payment products but cannot lend. This very important design feature has an important implication from a regulatory perspective – Payment Bank promoters now cannot “cross the floor” in terms of raising public deposits and lending these out. Therefore, the implications of “fit and proper” are now quite different for this group of promoters. This perhaps explains why this round produced eleven licenses against two in the last decade. And at this stage of development of the Indian banking sector, these eleven new entrants could be just what the doctor ordered for innovations on savings and payment services while not adversely impacting the stability of the banking system. An IFMR Finance Foundation working paper reported that the asset portfolio of the average rural household in India is composed almost entirely of two physical assets—housing and jewellery with little to no financial assets of any type.

Also from a financial system design perspective, this is a timely acknowledgement that the credit and payments strategy must evolve differentially within the broader financial inclusion strategy. While progress on credit would necessarily have to be much more measured and prudent no matter what strategies are adopted given the inherent risks and customer protection concerns, there is an urgent need to make access to payments ubiquitous. Yesterday’s announcement is an important step forward in that direction.

The RBI has published on its website the final Charter of Customer Rights for banking customers. This Charter has retained all the five Rights mentioned in the draft Charter previously published and includes:

Right to Fair Treatment

Right to Transparency, Fair and Honest Dealing

Right to Suitability

Right to Privacy

Right to Grievance Redress and Compensation

While all other rights have been captured to varying degrees in current customer protection rules and banking industry codes, the Right to Suitability has been enshrined by the RBI for the first time for retail customers of banks.

While Suitability as a regime was given legal recognition initially in Australia, and later on in other developed nations such as the UK, as well as in South Africa, a developing nation, the notion of Suitability as a right for retail consumers in India was first mooted by the FSLRC in 2013. The FSLRC called for three additional protections for retail consumers – these entailed the right to receive suitable advice, protection from conflicts of interest of advisors, and access to the redress agency for redress of grievances. Following this, the RBI Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households recommended that ‘every low-income household and small business must have a legally protected right to be offered only ‘suitable’ financial services. The RBI’s Charter enshrines the Right to Suitability as: The products offered should be appropriate to the needs of the customer and based on an assessment of the customer’s financial circumstances and understanding.

While there are certain divergences between the RBI’s definition and the definitions laid out by FSLRC or the CCFS, especially with regard to placing ‘customer’s understanding’ as a precondition, this is nevertheless a big first step in the same direction. The RBI has in its press release, also pointed out that all scheduled commercial banks, regional rural banks and urban cooperative banks are expected to prepare their own board-approved policy incorporating the five Rights of the Charter, and that such a policy must also contain monitoring and oversight mechanisms to be followed for ensuring that rights are not violated. This will pave the way for customer protection to shift from being an ex-post redressal process at the Banking Ombudsman along with self-regulation through industry bodies, to becoming a prerogative of the Boards of banks.

The RBI has published final Guidelines for Licensing of Payments Banks in India after reviewing feedback and comments obtained by it on the draft guidelines that were published in July 2014 and covered in an earlier post.

The Guidelines have permitted Payments Banks to be established under the Banking Regulation Act by a wide variety of eligible institutions and to be engaged in providing demand deposits and payments and remittance services to domestic underserved populations of small businesses and low-income households through own branches, ATMs, and BCs. There will be no credit intermediation including in the form of credit cards through these banks. An initial restriction of upto Rs.100,000 a year as maximum balance has been placed on such deposit accounts per individual customer. Payments Banks can be part of any card payment network and are permitted cash-out at branches, BCs, ATMs and Point-of-Sale terminals.

The final Guidelines provide more leeway to Payments Banks than what was previously proposed in the draft guidelines with respect to the following aspects:

Deployment of demand deposit balances

While previously 100% of funds were to be deployed in Government securities and T-bills with maturity upto 1 year, the final guidelines relax this to requiring a minimum of 75% in such investments. The Payments Banks are free to deploy the remaining 25% in current and time/ fixed deposits with other scheduled commercial banks for operational and liquidity management purposes. This component will also contribute to risk-weighted assets for market risk as previously there would have been be no capital required to be placed for market risk (due to zero risk-weights for Government securities/T-bills). Also, temporary liquidity needs can be met through the interbank uncollateralised call money market and the collateralised repo and CBLO markets.

Non-risk based backstop

The leverage ratio while previously set at not less than 5% (ie., outside liabilities must not exceed 20 times of its networth / paid-up capital and reserves), has now been eased to at not less than 3% (outside liabilities not exceeding 33.33 times of its networth/ paid-up capital and reserves). This shift is justified as a leverage ratio of 5% was more conservative than what is prescribed even for full-service banks, and also because Payments Banks have no credit risk to warrant such a strict requirement.

Retaining ownership by promoters

The draft guidelines had required mandatory dilution of promoter holding to prevent any self-dealing by the owners. The final guidelines specifically clarify that it does not mandate a diversified ownership structure, which would have been required if these banks were undertaking credit activities. Payments Banks can therefore be set up as fully-owned subsidiaries so that promoters can leverage adjacencies arising from the use of existing infrastructure of the parent companies by the subsidiary Payments Bank. When the Payments Bank reaches the net worth of Rs.500 crore, and therefore becomes systemically important, then diversified ownership and listing will be mandatory within three years of reaching that net worth. Payments Banks are free to list themselves before this too.

It will be exciting to see how the creation and performance of such Payments Banks will evolve now that the final guidelines have been published by the regulator.

The Report of the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (CCFS) was submitted to the Reserve Bank of India (RBI) in January this year. In the eight months that have passed, the RBI has accepted a number of the report’s recommendations including publishing of draft guidelines on licencing of payments banks, extending the right to suitability to customers of financial services, relaxation of Know Your Customer (KYC) norms, and restoring permission of ND-NBFCs to act as BCs of a bank, among others. These steps, in sum, represent the renewed vigour and focus on the financial inclusion and financial deepening agenda in the country. As we see progress on individual recommendations, however, it is important to keep in mind some of the larger themes and directional shifts that the report had recommended and to view each recommendation within the context of these.

The starting point for the report, in many ways, was to take stock of the previous and existing efforts on financial inclusion in the country. Over the years, India has seen many big ideas on financial inclusion; from cooperative banks, nationalisation of banks, self-help groups, and regional rural banks to business correspondents, India has moved from one big idea to another in addressing the country’s financial inclusion puzzle. In examining these programs, the CCFS recognised that the key, common weakness of previous efforts on financial inclusion was their over-reliance on the one big idea as the key to financial inclusion. In this light, the recommendations of the CCFS mark a significant break from the trend of “magic-bullet” solutions. The report recognises that in a country as large and diverse as India, a reliance on any single approach to solve problems is bound to fail. While acknowledging that the country will need to constantly explore new ideas, learn from new technology and successful strategies of other nations, the report argues that the best regulatory strategy is not be to push the design of the financial system towards one central approach. Rather, the CCFS proceeds to define a clear set of vision statements and establish core design principles that would enable multiple institutional frameworks and models, new and old alike, to thrive or wither away, based on their inherent strengths and weaknesses. (Page 5, Preface, Report of the CCFS)

Design Principles

Keeping in with this strategy, the report presented a set of four principles that should guide the evolution of the financial system design in India – Stability, Transparency, Neutrality, and Responsibility. To elaborate, the principle of Stability argues that any approach that seeks to achieve the goals of financial inclusion and deepening must be evaluated based on its impact on overall systemic risk and stability and at no cost should the stability of the system be compromised. A well-functioning financial system must also mandate participants to build completely transparent balance sheets that are made visible in a high-frequency manner, accurately reflecting both the current status and the impact of stress situations on this status. Furthermore, the treatment of each participant in the financial system must be strictly neutral and entirely determined by the role it is expected to perform in the system and not its specific institutional character. Lastly, the financial system must maintain the principle that the provider is responsible for sale of suitable financial services to customers and ensure that providers are incentivised to make every effort to offer customers only welfare-enhancing products and not offer those that are not.

In articulating these design principles, the report argues that any institutional model for the delivery of financial services should be encouraged as long as it passes the litmus test of adhering to these principles.

Let a hundred flowers bloom

At its core, then, the CCFS recommends an approach that moves away from an exclusive focus on any one model of financial inclusion and financial deepening to an approach where new and specialised entrants are permitted and multiple models and partnerships are allowed to emerge between these specialised entities. The recommendation on allowing NBFCs and now, payments banks to act as BCs of banks, perhaps, best represents fruitful partnerships among specialists. Thus, instead of focussing only on generalist institutions that are required to deliver on all functions of finance, the report recommends developing a vertically differentiated banking structure, in which banks specialise in one or more of three functions- payments, credit delivery and retail deposit taking. The Committee, thus, recommended the licensing of new categories of specialised banks including Payments Banks and Wholesale Banks.

As the report mentions, India already has the elements for success in place – a wide range of institutional types, well-developed financial markets, a good regulatory framework, and large scale and high quality authentication and transaction platforms. The cause of financial inclusion and financial deepening would be better served if we could allow institutions to leverage on this and evolve naturally, in multiple directions.

The Committee on Comprehensive Financial Services for Small Businesses and Low Income Households recommended developing a vertically differentiated banking structure, in which banks specialise in one or more of three functions- payments, credit delivery and retail deposit taking. The Committee, thus, recommended the licensing of new categories of specialised banks including Payments Banks and Wholesale Banks. Accepting the Committee’s recommendations, the Reserve Bank has released Draft Guidelines for ‘Licensing of Payments Banks’. The Draft Guidelines state that the “primary objective of setting up of Payments Banks will be to further financial inclusion by providing (i) small savings accounts and (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments / remittance services in a secured technology driven environment.

Such Payments Banks would engage in collecting demand deposits (ie, savings bank deposits and current deposits) and provide payments and remittance services, such that the deposits are deployed in Government securities and T-bills (with maturity upto one year) permitted by RBI as eligible for meeting SLR requirements. With access to the Payment and Settlement System, Payments Banks will be permitted to carry out cash-in and cash-out through channels such as own branches and through BCs, and can additionally do cash-out at ATMs as well as POS terminals (subject to instructions under the Payment and Settlement Systems Act). RBI would also be open to entities interested in offering transactions through the internet (similar to the Virtual Bank model in Hong Kong). The deposits will be protected by deposit insurance under DICGC.

Transaction limits while currently set at Rs. 100,000 as maximum balance per customer, can be subject to revision based on performance of this category of banks. Also, if ‘small accounts’ are being offered, these would enjoy the benefit of simplified KYC norms.

Payments Banks are expected to stay away from credit intermediation on own books and thereby not be exposed to credit risk (nor market risk if investments are held to maturity obviating the need to mark-to-market) but be exposed to significant operations risk as well as liquidity risk. The minimum capital requirement set at Rs. 100 cr (one-fifth of that for a full-service bank) is substantiated given that the expectation is that the operations will entail significant investments in technology and fixed assets. Although there will be no credit risk, the Draft Guidelines have envisaged a minimum capital adequacy ratio of 15%, as is the case with NBFCs, the calculation of which will be based on simplified Basel I requirements (perhaps, risk weights for cash in hand and cash in bank would take prominence in the absence of loans and other assets).

Payments Banks will necessarily have to be public limited companies and entities interested in setting up Payments Banks are to have a past successful track record of atleast 5 years in running their business, be it an NBFC, a corporate BC, mobile telephone companies, super-markets or others. Interested banks can also set up Payments Banks subsidiaries subject to shareholding limits.

As has been in the case with the previous round of bank licensing requirements, Promoters of Payments Banks would need to systematically bring down their holdings from atleast 40% (locked in for the period of first 5 years), brought down to 40% within first 3 years, to 30% within 10 years, and to 26% within 12 years of commencement of business.